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Summary - Unit 4 ECON4 - Economics: Monetary Policy £8.16   Add to cart

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Summary - Unit 4 ECON4 - Economics: Monetary Policy

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Detailed notes on the monetary policy using the AQA A Level Economics Specification.

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  • August 7, 2024
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MACRO 11

MONETARY POLICY
 Monetary policy is manipulating the supply of money in the economy in order to achieve
economic objectives
 Not just interest rates

Evaluation
 The real rates are significant
 The real interest rate is the nominal interest rates minus inflation
 If inflation rose from 5-6% but inflation rose from 2-5.5%
 Represents a cut in real interest rates from 3-0.5%
 In this circumstance the rise in nominal interest rates actually represents expansionary
monetary policy
 Time lags
 Can take up to 18 months to have an impact
 Fluctuations in interest rates don’t have uniform impact on the economy
o Some industries are more affected than others
o Some regions are more sensitive
 Markets which are most affected are those where demand is interest elastic when the
market demand responds elastically to a change in interest rates
o Interest sensitive industries are these directly linked to demand conditions in the
housing market, exporters of manufactured goods, construction industry and leisure
o Demand for basic foods and utilities is less affected by short term fluctuations in
interest rates
 Decreasing interest rates and increasing the money supply has less impact than doing the
opposite
 If consumer confidence is low the impact of monetary stimulus might be small
o People are more likely to save
 If asset prices are falling the demand for cash savings will remain
 Limits to how far monetary policy can go in boosting demand
o Nominal interest rates cant fall below zero
 Interest rate cuts may not be passed on
o Especially if there is a cut in the base rate

Transmission mechanism
 Changes in the interest rates alter the consumer price inflation
 Evaluation
o Time lag
o Vulnerable
o BoE opting to not change interest rates
 High street rates are not the same as interest rates
o Market interest rates
 Banks make all their money from lending and changing interest rates
 Banks are keen for increasing interest rates but not decreasing interest rates as they make
more money
 The Bank of England changes the base rate set by the MPC (monetary policy committee)
o Market interest rates – savings rates and credit cards
o Asset prices – house prices
o Expectations and confidence
o Exchange rate – flows of hot money

, i. Affects import prices which affects consumer price/ cost push inflation
 All of the above are affected by each other as well as the change in the base rate
 Domestic demand – C + I + G
 Net external demand – X - M
o Affects aggregate demand
i. Affects domestic inflationary pressure which affects consumer price/
demand pull inflation

Quantitative easing
1. Central bank creates money
2. It uses the new money to buy bonds from financial institutions including pension firms, non
financial companies, commercial banks
3. This leads businesses and people to borrow more
4. This reduces interest rates
5. More money is spent and jobs are created
6. This all boosts the economy
 ‘Printing money’
 Commercial banks sell bonds to the Bank of England so they make more loans and charge
interest and lend this increase in money to the rest of the country which stimulates
investment and growth of the economy
 Purchasing assets financed that the banks own electronically
 Most assets purchased are government bonds
o There is a large market available so the bank can buy substantial quantities of assets
quickly
 Higher asset prices also make some people better off which provides an extra boost to
spending on goods and services
 The yield is the interest expressed as a proportion of the market price of the bond
 Implemented in recessions or when there is deflation
o Financial crisis
o COVID-19 pandemic
 Aim is to boost spending to keep inflation on track to meet 2% target
o Alongside its decisions on asset purchases the MPC continue to set bank rate each
month
 Deflation is harder to solve
o Deflationary spiral
o Banks are more reluctant to pass on a cut in interest rates
o You can’t set negative interest rates
o There is low confidence in a deflationary economy – businesses are reluctant to
invest
 Makes the price of bonds increase which makes people more willing to sell their bonds to
the government
o This makes the yield decrease on the bonds as the interest doesn’t change but the
price does
o Banks should switch into different financial products meaning there is an increase in
the amount of money and lenders available
 The interest on debt is a key factor which affects people’s lending and spending

Evaluation
 Higher asset prices lead to rising inequality as the people with many government bonds tend
to be those who are wealthier

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